Politicians rarely volunteer to give away big chunks of their fiefdoms. But
that's what State Treasurer Ted Wheeler is proposing with the Investment
Modernization and Cost Reduction Act.

The bill would establish Treasury's investment management division as a
public corporation, transferring an obscure but critical piece of the state's
bureaucracy outside the agency's auspices -- and outside the budgetary control
of the Legislature.

Today, the Treasury division's 25 employees oversee some $70 billion in
assets from the state pension, school and accident insurance funds. If the bill
passes, they would be employees of the Oregon Investment Corporation, a
quasi-public entity run by an independent board of directors, similar to Oregon
Health & Science University.

As its name implies, the proposal is being billed at the capitol as a cost
savings measure. But for now, the forecast savings are small -- less than 3
percent of the $365 million in management fees paid in 2011.

The real goal is to reorganize who runs the organization and how, take its
purse strings away from Legislature, and beef up risk-management and back-office
functions that managers say are perilously thin today.

The structure of the investment division is essentially unchanged since the
1970s, while the size and complexity of the investment portfolio ballooned. Only
60 percent of the portfolio today is traditional stocks and bonds, while
investments in illiquid and less transparent private partnerships have
proliferated as the state seeks to bolster returns and diversify assets.

In a study last year, Funston Advisory Services concluded that Oregon's
pension investment portfolio is one of the riskiest among comparable public
funds. Yet it found the division was severely understaffed for investment
monitoring, accounting and risk management.

The governor appoints members of the Oregon Investment Council, a
five-member citizen's board that oversees policies and approves specific
investments. But the board has no authority to hire and evaluate staff. They
report to the elected Treasurer, who sits on the board, but may or may not be a
financial expert or have the same agenda as the council.

Funston concluded that the authorities and responsibilities of the
Treasurer, the OIC and the PERS Board were misaligned and sometimes conflicting.

"We've been fortunate to have an OIC and Treasurer who get along well,"
said Keith Larson, chair of the OIC. "But you could easily have a big problem.
There's all this responsibility invested in the OIC, but no authority."

In fact, neither the investment division nor the OIC are strangers to
scandal, having weathered political and financial conflicts over the decades.
But with investment returns that have exceeded most peers, there has been little
push to change the basic structure of the organization.

Today, Oregon outsources almost all investment and risk management to Wall
Street banks and consultants, employing a skeleton staff to monitor the
managers. It's an expensive choice. It doesn't yield better results in all asset
classes. And it puts Oregon on the end of the spectrum of large pension funds,
many of which are internalizing investment management to save money, and
building more robust risk management teams.

The OIC and Wheeler would like to do the same. And they could do so without
setting up a separate entity.

In fact, Treasury has submitted a separate budget request to add 27
positions, including a new investment officer, a team of risk managers, several
research analysts and support staff. The cost would be $3 million a year.

But Wheeler says good governance is often at odds with good politics. With
the state budget in chronic shortfall, the Legislature is loathe to approve new
positions, even when the money would come from management fees charged to the
pension fund, not the state general fund.

"If we want additional positions, we have to go through a six month
legislative process, at the end of which we fail in terms of being able to staff
up the way we want," Wheeler said.

Unspoken, but also politically inconvenient is the compensation to attract
talent from the private sector. The state's existing investment officers are
some of the best paid public employees, making an average of $200,000 a year.
But Treasury officials quietly complain that staff is underpaid by industry
standards, and bristle about having to explain and get approval from the
Legislature to release performance-based pay each year.

The passage of the bill would turn the whole operation over to the Oregon
Investment Council, which would hire an executive director, carry out the
reorganization, then preside over the new public corporation and its budget. The
legislation would also get rid of term limits for council members.

The pitch to lawmakers is that all this could be accomplished for less
money. The agency figures it could save $12 million without sacrificing any
investment returns by managing part of its stock portfolio in house, indexing
the market rather than paying a bank to actively manage a portfolio of stocks.

Eventually, the division could bring more of its asset management in house,
saving as much as $90 million in fees annually if it were structured similarly
to peer funds, according to consultants' estimates.

Yet Deputy Treasurer Darren Bond said regardless of whether the division
brings the asset management in house, the agency needs more staff: "If there
wasn't a dime of savings here, you still need to get to the better governance
structure and appropriately resource this operation."

It remains to be seen how Legislators will react.

Betsy Johnson D-Scappoose, said she's generally supportive of the concept,
but that the Legislature needs a robust discussion on how the governor picks
members of the investment board.

For his part, Wheeler's convinced a public corporation is the better way to
go.

"I'm giving up some of my powers as state Treasurer, but I'm doing it for
what I think is a good cause."